UK: Sobering Up an Unbalanced Economy

This is an excerpt from my regular column, available to subscribers on www.thesundaytimes.co.uk

Though George Osborne exaggerated it by smattering his Commons speech with so many projects and commitments you had to listen hard for the cuts, the spending review was better than feared.

The headline figure of £81 billion cuts by 2014-15 is still eye-catching, the difference between the planned total and what was needed to keep up with inflation. £10 billion of that £81 billion will hurt nobody, however, being the reduction in debt interest.

There will be losers but for years experts have called on governments to do something about inexorably rising welfare spending, so £18 billion (£7 billion of which was announced last week) was a good start.

Limiting the cuts in spending in non-ringfenced departments to 19% over four years not only allowed the coalition to make a political point at Labour’s expense (though stretching the data to do so) but it increased the chances of achieving them. The difference between 25% real cuts and 19% may not sound huge but it could be very significant as governments get down to the hard job of delivering them. Finding an extra £2 billion for capital spending, admittedly because existing contracts could not be broken, ensured a supportive nod from business. None of this disguises the fact that it is tough, as the IFS reminds us. It is the toughest for overall spending since the war, for spending on public services since 1975-80s, and even for the ringfenced NHS the toughest since 1951-56, just after it came into being.

But some of the commentary on the spending review was, frankly, silly. To admonish Osborne for using the analogy of a household living beyond its means confuses the use of an explanatory political device with the underlying analysis.

The Treasury has many faults but it knows the difference between household finances and the public finances. Similarly, to attack deficit-cutting as “pre-Keynesian” policy ignores most post-Keynesian economics, much of which has demonstrated the limitations of fiscal policy.

One surprise to have emerged from the crisis is how many unreconstructed Keynesians still exist. This may be an age thing – people who studied economics at a particular time – but it is nonetheless surprising.

I had thought this had disappeared at roughly the time of former Labour prime minister James Callaghan’s “you can’t spend your way out of recession” speech in 1976. I do not recall much of it when the Conservative government embarked on a similar fiscal tightening in the 1990s.

Keynesians looking for support in the great man’s General Theory for running big budget deficits indefinitely will not find it. As Sir Samuel Brittan, a critic of the cuts, noted ruefully in a recent speech: “Unfortunately Keynes did not take the final logical step of endorsing budget deficits and indicating their safe and desirable limits.”

Now the overall spending allocations have been made, two things will happen. Government departments will publish business plans, not providing line by line detail of cuts but timetables for departmental priorities, and indicators by which the achievement of these should be judged.

The more tiresome development will be that every economic morsel will be seen through the prism of “the cuts”. Rare too will be the company statement that does not include a reference to public spending or tax increases, or both.

One key test of the fiscal plans is the recovery’s durability. Economists have no real excuse for using the spending review as justification for lowering their forecasts. The £81 billion of cuts announced last week were marginally less than the £83 billion signaled in the June budget.

Those cuts, according to the Treasury’s latest compilation of independent forecasts, were consistent, on average, with 1.9% growth next year, not rip-roaring but a recovery. If they are revised down, logic suggests it will not be because of the cuts. The debate will run and run.

The other requirement for the next few years is that the economy rebalances. “The case for rebalancing is even stronger in the wake of the financial crisis and recession that followed the nice decade,” Mervyn King said last week.

“To achieve rebalancing we need to sell more to and buy less from economies overseas. To close the gap between exports and imports, more than half a million jobs will probably need to be created in businesses producing to sell overseas – compensating for fewer employment opportunities serving consumers or the public sector.”

The Bank of England’s acronyms department has come up with a new one for the governor, Britain’s “sober” decade of savings, orderly budgets and equitable rebalancing. It does not trip off the tongue.

Balancing the government’s books and balancing the economy should be part of the same story. When household incomes are squeezed by benefit cuts, other spending reductions and tax hikes, consumer spending should grow more slowly.

In the tightening of the 1990s, when a budget deficit of 8% of gross domestic product was turned into a surplus in five years, Britain’s trade position improved in tandem. The current account went from a deficit of 5% of GDP to balance by 1997.

People are gloomier this time about exports, because of a perceived reluctance of firms to take advantage of sterling’s lower level, currently 23% below pre-crisis levels on an average basis. Companies, it is said, are increasing their margins rather than their export volumes.

Export volumes have, however, risen by a strong 14.5% over the past year. The challenge of eliminating the current account deficit, currently 2% of GDP, is less.

The conditions are in place for the recovery to be a balanced one, led by exports and investment, as happened for several years in the 1990s. As with cutting the deficit, there is really no alternative.